NFTs for Newbs | Part IV

Legalities.

coindesk.com

What do you get when you buy an NFT?

1. A digital token that serves as a receipt.
2. A link to an underlying asset.
3. Media coverage and bragging rights.

What don’t you get when you buy an NFT?

Rights to the intellectual property (IP) of the underlying asset. If you buy a painting, you get a physical canvas, not permission to make and sell posters. Section 106 of the U.S. Copyright Act says that the copyright owner has the exclusive rights to reproduce, modify, display, and distribute the art. These rights only transfer through contract.

What about the “First Sale Doctrine?”

This law states that when you purchase a physical work (painting, book, baseball card), you can sell, display or modify it without permission. The US Copyright Office refused to apply this to NFTs, because digital assets can be “reproduced perfectly,” whereas physical works “degrade with time and use.”

Who is the copyright owner?

The original, independent creator.

What if I made something under employment, AKA “work for hire”?

According to the Copyright Act, when an individual creates work under contract, the employer owns the copyright. Artist Krista Kim sold Mars House, the “first NFT digital house in the world,” for $500k+. Mateo Sanz Pedemonte, a 3D-modeller who contributed to the project threatened to sue Kim for copyright infringement. But Kim hired Pedemonte as a freelancer and never granted IP.

What are marketplaces doing about IP questions?

OpenSea:

1. NFTs will be removed “in response to formal infringement claims” and users deemed “repeat infringers” will be blocked from the platform.
2. The Terms of Service advises copyright holders to file complaints if needed.

SuperRare:

1. Informs buyers that they do not get the IP of an underlying work and artists do not lose IP over sold items, unless expressly conveyed and signed in writing.
2. Warns artists to refrain from minting work “containing copyrightable elements of another’s” unless authorized by the owner or can argue a valid Fair Use defense.

AtomicAssets:

1. Cautions visitors that anyone can create NFTs on their platform and “freely choose attributes such as name and image, including fake versions of existing NFTs or stolen IP.”
2. Advises buyers to conduct their own research about the collection and “double check the collection name” to ensure authentic pieces.

Why do some buyers sue sellers?

1. Fraudulent seller: Seller pretended to be someone else (like a celebrity).
2. Fraudulent sale: Seller sold something counterfeit, like a knockoff Banksy.
3. Breach of contract: Seller claimed the NFT was a limited edition, but then sold additional copies.
4. Securities Act: If an NFT is sold as a security, but the value drops.
5. Misrepresented rights: Rights were not fully disclosed.

What is a security?

When you buy something only to sell it in the future for a profit.

How do you know if something is a security?

The Howey Test. It was developed in 1946 from the Supreme Court case SEC v. W.J. Howey Co. and lists three criteria:

1. An investment of money.
2. An expectation of profits.
3. Profit is earned from the efforts of the third-party entity.

Are NFTs securities?

1. No → if they are marketed as a collectible and tied to an asset (NBA clip).
2. Yes → if they are sold with the promise of a return, and the issuer influences its value in the secondary market.

How to grant someone limited IP rights?

Through a license, a signed document with explicit ownership rights.

What are some licenses and what can I do with them?

1. NBA Top Shot: A non-exclusive license “to use, copy, and display” a moment for “personal, non-commercial use.”
2. CryptoKitties: A commercial license to sell products featuring kitties as long it does not generate $100k+ in annual revenue.

How can I make a license?

Dapper Labs, owner of NBA Top Shot, shared an NFT License template that sellers can adopt. It separates the token from the underlying asset and states that the buyer receives a personal license to use and display the associated art.

What rights do artists have?

1. Visual Artists Rights Act (VARA): It is illegal to intentionally modify pieces of “recognized stature.” The people who burned the Banksy and minted the recording may be subject to liability. Others argue they are protected under the Fair Use defense if the burning transformed the piece into new art or the video added to work.
2. Fair Use: Artists can use copyrighted materials for “transformative” purposes including “criticism, comment, news reporting, scholarship or research.”
3. Right of Integrity: It is illegal to modify art in a way that would ruin its “honor or reputation.” This only applies to “fine art” of “recognized stature” (the stature of NFTs is yet to be determined).
4. Right of Attribution: It is illegal to take credit for someone else’s work.

Any other legal concerns surrounding NFTs?

1. Royalties: US law does not recognize resale rights for artwork, so don’t expect aid for unpaid royalties (UK does).
2. Imitators: Imitators are borrowing assets and creating similar art. Copyright holders may sue, but the NFTs may fall under the Fair Use defense where the art is transformative or the artist “had a genuine creative rationale for borrowing.”
3. Copyright Infringement: Sellers minted NFTs of assets they do not own. For example, Mickey Mouse-related NFTs without permission from Walt Disney.
4. Tax Law: Right now, no one is collecting sales tax…this may yield ramifications retroactively.
5. Insurance: NFTs are hard to insure as there is “currently no equivalent for NFTs in the registry of stolen artworks maintained by the FBI, Interpol, or the Art Loss Register.” It is hard to put a value on an NFT, the sale price may be insufficient proof.
6. Money Laundering (ML): Criminals abuse cryptocurrency and the art market to launder illicit sources of money. Since NFTs are a combo of both, it may be the “best money laundering method in the cryptocurrency world.” Auction houses are still developing Know-Your-Transaction (KYT) and Know Your Customer (KYC) processes to prevent ML.
7. Compliance and trade regulations: The Office of Foreign Asset Control (OFAC) warned that expensive art transactions “may play a role in blocked persons accessing the U.S. market and financial system in violation of OFAC regulations.” The Trading with the Enemy Act does not allow “blocked persons or their facilitators to evade sanctions by exchanging financial assets such as cash, gold, or cryptocurrency for high-value artwork or vice versa.” NFT traders could be anywhere in the world, so participants should confirm they are in compliance with the regional law.
8. Verification: The blockchain records transactions, but there is no way to tie a digital key to a physical person. To help combat this, SuperRare requires artists to submit an application that collects info including name, email, portfolio and social media accounts. This can help ensure collectors receive authentic pieces from reputable artists with valid rights.
9. Hacking: Marketplace visitors should review the Terms of Use to understand their options in case of hacks. People tweeted that their accounts were hacked on Nifty Gateway; one person reported $150k+ worth of NFTs missing. Nifty responded, “none of the impacted accounts had [two-factor authentication] enabled, and access was obtained via valid account credentials.”
10. Data Protection: Given the immutable nature of the blockchain, NFTs that contain personal info violate data protection laws which grant people the right to delete personal data or fix inaccuracies.

How can marketplaces minimize litigation risk?

1. Draft clear contracts that explicitly address the legal issues.
2. Consider securities registration requirements.
3. Confirm traders comply with federal regulatory obligations.
4. Develop KYT and KYC procedures.
5. Investigate suspicious activity.
6. Facilitate trades on a public blockchain, not a private/proprietary one to minimize liability.

Opportunities for marketplaces?

1. Implement tech that identifies copyrighted assets in NFTs and require sellers to prove rights (through documentation) before listing.
2. Implement a monetization mechanism that divvies royalties to the copyright owner(s) on each resale across marketplaces.

So what?

Specialist art lawyers may be a budding career choice.